If you watch any of the cable news shows you have no doubt seen former actors pitching Reverse Mortgages. These are the commercials where they talk about how you can turn your home equity into cash and never have another mortgage payment. So how exactly do these work?
A Reverse Mortgage is an FHA insured loan against your house, it is that simple. But unlike a conventional mortgage where you pay it back over a 15 or 30 year period, with a reverse mortgage you don't make payments. It is basically a trade where you trade the mortgage company your home equity and they trade you a monthly payout or lump sum. The mortgage company is foregoing the monthly payback in hopes of recouping their investment + interest down the road when you either sell the property or pass away and your estate hands over the keys to the house.
In the past Reverse Mortgages had a bit of a negative stigma as the closing costs were very high. All reverse mortgages are required to have Mortgage Insurance which can run as much as 2% of the home value in addition to standard closing costs, all told this could mean 3 1/2% in costs at the closing table. Newer products allow for much less in closing costs, but they limit the amount of cash that the borrower is able to take out of the home equity.
A couple of key facts:
- you have to be 62 or older to do a reverse mortgage
- the home has to be your primary residence
- you have to maintain the property, pay your prop taxes and insurance
- the loan is similar to going to the bank and getting a home equity line of credit against your house, the difference being you get the money and don't make any payments (they are deferred upon the sale of the home)
- the loans are non-recourse meaning if you did a reverse mortgage and the real estate market tanked, you (or your heirs) are not liable for any loss the mortgage company incurs. Your heirs just hand over the keys and walk away.
- the amount of equity you can pull from your home varies with age. If you did a reverse mortgage at age 62 you might get up to 50% of your equity out. If you did a reverse at age 82 you might get up to 70% of your equity out. (estimations only)
When would a reverse mortgage work for someone?
Prior to getting a reverse mortgage it would be advisable to consult a financial planner to have them review the entire picture, but here are some cases where this tool could be used:
- you are retired and realize that you want to stay in your home through the remainder of your life, but the mortgage payment is eating up a big portion of your cashflow. Would having no mortgage payment plus extracting 60% of your existing equity help?
- you are retired and would like to pay cash for a second home or rental. By extracting the equity in your primary residence with a reverse mortgage you now have funds to pay for this second home or rental and no primary mortgage.
These of course are very generic situations and as all tools there is a tradeoff (and that is giving up a good percentage of your home equity). While you may still be able to sell your home, payoff the reverse mortgage and walk away with cash in the future, you need to approach this as if you will live in your home for the remainder of your life.